Refinancing Mortgage Loan Q and A
Refinancing your current loan is obviously an important decision that can save you hundreds of dollars each month. Refinancing is, in the simplest terms, taking out a new loan to pay off and replace your existing mortgage loan.
Q. How do I know whether I should refinance my existing loan?
There are three basic situations where refinancing your loan makes a lot of sense.
The first is if you qualify for a lower interest rate than what you are currently paying. However, you have to calculate how long you plan to keep this new loan as refinancing costs money -- closing costs, broker's fees, points, etc.
Another situation that may call for refinancing is if you have an option ARM (adjustable rate mortgage) that is going to expire in the next few years and you believe that when it does interest rates will be less favorable than they are today.
Finally, refinancing may be a good option if you have gained significant equity in your home. Let's say, for instance, that you have a second loan at a fairly high interest rate – you may be able to refinance the entire loan into your first – thus saving you hundreds of dollars on interest payments that higher second. This is especially true if your second is a home equity line of credit that is directly tied to the Fed interest rate.
Q. When should I "lock in" an interest rate?
Obviously, you want to lock in an interest rate at the lowest possible rate possible when you go to refinance. Historically, rates tend to rise faster than they fall. Therefore, it's not a bad idea to lock your rate in as soon as you or your mortgage broker thinks rates are at a competitive level for that month. Remember, it is always possible to refinance later if rates continue to drop.
Q. If I want a cash-out refinance will I pay a higher interest rate?
The rate of interest that you pay on a refinance loan and a cash-out refinance should be the same. Cash-out loans may involve several fees depending on the type of loan and the LTV (loan-to-value) ratio. Before you decide to do a cash-out refinance loan, consider using equity from your home to finance or pay off your existing bills such as auto loans, credit card bills or college tuition (the interest on these types of loans are non-tax deductible.)
Q. Which is better, an adjustable rate mortgage or a fixed rate?
The answer to this question is wholly dependent on your situation. If you are a young buyer who is purchasing your 1st home and plan on being in it no longer than a few years, than an option ARM is probably the best option as the interest rate will be lower than a fixed rate. However, let's say you've just retired and as a couple you decide to downsize to a smaller house and stay there for the next 30 years, than a fixed rate mortgage is probably your best bet.
Q. How much money do I need to cover the closing costs?
As a general rule, you will need 2% of the home's purchase price for prepaid interest to cover the time between the date you close your loan and the date you make your first mortgage payment. Some states may also require pre-payment of property taxes . When refinancing however, your old mortgage will most likely have money in an escrow account that can cover these costs. Some borrowers get short-term loans while their escrow transfers back to them, but most pay the money at the closing knowing they'll get it back when their escrow is returned.
Q. Are there really loans with no closing costs?
It would be very rare to have a loan with no closing costs. If you are an excellent candidate with great credit and the lender knows your refinance loan will be a synch, they may waive the application fee and could cover the appraisal and title. Typically, if the lender covers these fees they make it up by charging a slightly higher interest rate. Another option that lenders can take is to roll these fees into the loan amount, meaning that there are few up front fees, but they are still be collected by the lender.
In the end, the lender and/or the mortgage broker needs to make their money for the work they do and the set costs of refinancing a loan – namely, the appraisal and title fees.
Q. Is it a good idea to pay points to get a better interest rate?
Paying a point essentially means paying 1% of the loan at the time of refinancing in order to pay down the interest rate. As a general rule of thumb, a point paid towards a loan will reduce your interest rate by 0.25 percent. If you intend to refinance your loan in a few years (the average Americans refinance their loans every 3 years – although this is much more common during periods of relatively low interest rates) it probably DOES NOT make sense to pay a point. The reason is that it may take several years to make up the initial point payment. Conversely, if you intend to keep your loan for man years than paying a point towards the loan makes a lot of sense.
This means it could be several years before your lower rate makes up for the points you pay. However, if you're buying a home, points paid are a tax-deductible expense for that year. Please consult your tax advisor.
Q. What is the typical time it takes to refinance?
Refinancing a home mortgage can take anywhere from 7 days to a month, depending on how fast the lender is given a recent home appraisal, how many refinancing loans they are processing, any outstanding liens or recent debt that may affect the borrower's credit worthiness, how many comparable homes are in the neighborhood and how quickly your broker or lender prepares and executes your paperwork.
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